Grim and bear it: S&P set to re-evaluate ratings of two top distributors - Avnet, Arrow Electronics

Electronic News, August 5, 2002 by Heidi Elliott

Already battered by the industry downturn, the electronics industry's two top distributors are facing a credit review by Standard & Poor's Ratings Services-and may see their credit rating fall as a result.

S&P placed its ratings on both Avnet Inc. and Arrow Electronics Inc. on "CreditWatch with negative implications," which means that an S&P committee will meet with each company's management to discuss its short-term outlook on cost-structure reductions, earnings improvement and industry conditions. S&P has concerns about the distribution industry's outlook and whether the companies can improve earnings and debt-protection measures. After the review, S&P will either leave the ratings as they are (BBB for each company) or lower them.

"It's not so much relative to the fact that their performance varies from what we had expected from the most recent quarter; it's more about macroconditions," said S&P credit analyst Martha Toll-Reed. "Both companies have done what we expect a distributor to do in a downturn-they have generated cash and used cash to pay down debt."

However, when S&P issued the current ratings a year ago, it expected market conditions would improve in the second half of this year. That expectation has fallen by the wayside. Now, recovery for the entire electronics industry is not expected until 2003, so it's appropriate to reconsider the ratings. The committee of S&P analysts, said Toll-Reed, will have to decide whether to give the industry more time to recover or whether it's had enough time.

The next lowest rating is a BBB-, which is still an investment-grade rating. Should the ratings be lowered one notch, it would likely not have a significant impact on either company's ability to borrow capital. However, BBB- is the lowest investment-grade rating. Once a company goes below that rating, said Toll-Reed, it becomes a problem. A noninvestment grade rating would likely result in harm to the company's stock price.

S&P maintains ratings on two other distributors. Cleveland-based Pioneer-Standard aw its ratings get downgraded in. June--going from a BB to a BB-with a negative outlook. Privately held Memec Group is rated at BB stable. And while there has been no change in its ratings, Toll-Reed said that's because Memec's rating was based on the assumption that the company would incur more debt (sticking to its original capital structure). Since Memec did not incur the level of debt called for originally, the rating did not change.

While neither distributor is likely to seek additional credit at this point in time, anyway, executives at the two top distribution companies agree that a review is in order. "The review is propelled by a longer and deeper downturn...it's caused them to rethink where we are going," said Arrow Executive VP Robert Klatell. "From Arrow's point of view, we are very comfortable with our balance sheet and our liquidity."

Klatell added, "I don't think other companies in the electronics supply chain have done as well as distributors. It shows the resiliency, strength and adaptability of distribution."

Avnet CEO Ray Sadowski concurred. "This is the most significant downturn we've ever faced and it has gone on longer than any of us had hoped, so it's logical to review the rating. Although I think everyone will agree that business has bottomed out."

Neither of the top distributors has stood still during the downturn. Avnet has made a series of cost-cutting moves and reduced its total debt level, including off-balance-sheet receivables financing, by about $1.5 billion in the last 18 months. Meanwhile, Arrow has reduced its total debt in the one-year period ending in March by $1 billion compared to 2001 levels. Arrow currently boasts of about $900 million in cash on its balance sheet.

Looking at current market conditions, Sadowski sees a slight improvement in business conditions. "It would surprise us if they downgrade [the rating.] We have shown steady improvement all during our fiscal year," he said. "For them to take any sort of severe credit action would ... make a statement about the distribution industry overall."

[GRAPH OMITTED]

Arrow Electronics

Rating: BBB

Watch Negative

S&P will review its rating and may revise it

Avnet

Rating: BBB

Watch Negative

S&P will review its rating and may revise it

Memec

Rating: BB/Stable

Unchanged

Pioneer-Standard

Rating: BB-

Revised down in June from a BB rating

SOURCE: S&P